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Disclaimer: This is not financial advice
There is little doubt that there is increasing demand for sustainable, responsible and impact (SRI) investing strategies, particularly among younger investors. Environmental, Social and Governance (ESG) assets are set to exceed US$50 trillion by 2025, comprising more than a third of total global assets under management, according to Bloomberg Intelligence. In light of this, it is unsurprising that money managers have taken advantage of this in rebranding underperforming funds under the ESG banner to attract greater inflows. But are these ESG funds really sustainable?
In 2020, a record 25 funds of companies managing mutual funds and ETFs were rebranded as sustainable, with 64 being rebranded since 2016. More telling however is the fact that 35 of the total 64 rebranded funds experienced investor outflows in the three years prior to rebranding, as The Wall Street Journal found.
In recent times, ESG scrutiny has intensified as many SRI investors are more aware of the threat of “greenwashing”, which is the practice of misrepresenting the extent to which a company or investment is environmentally friendly, sustainable or ethical. The fund industry has received much criticism in the marketing of ESG funds that fail to live up to their name, and this has particularly been the case as the investment composition of rebranded funds has not changed as dramatically as one would expect. For example, the USAA Sustainable World Fund (previously the World Growth Fund) holds over 6% of its $1.5 billion in assets in controversial oil and gas companies, according to As You Sow. That’s not to say that every fund that rebrands does so in name only. Notably, the Putnam Sustainable Future Fund (previously the Multi-Cap Value Fund) has shifted 75% of its portfolio to sustainable companies.
Essentially, the problem boils down to one thing: how we define “sustainable”. Is screening out tobacco companies, weapons manufacturers and the like good enough? Does it require actively making investments in companies that are trying to make an actual difference? Additionally, what is the most important factor to consider: the E, S or G? However, even though everybody’s perception of what constitutes ESG is going to be different, at times it seems the efforts of money managers amount to little more than window dressing.
Moreover, although the current countervailing narrative is that SRI investing strategies deliver outperformance, the true picture might be more complicated. Indeed, part of the outperformance reflects the dominance of technology stocks in these funds, which have rallied massively recently under one of the longest bull markets in history. For example, the top four holdings in the American Century Sustainability Equity Fund (previously the Fundamental Equity Fund) are Microsoft, Alphabet, Amazon and Apple.
None of this is to say not to buy into ESG! With the boom in sustainable investing likely here to stay, what is clear is that retail investors need to take due diligence in understanding the methods used to evaluate the sustainability of funds they are interested in. Regardless of the type of investment, it is always important to know what your fund actually holds.
